Monetary policy works by decreasing the money market risk free interest rate, lowering the price of credit and the return on money. That induces firms to change the composition of their financing and asset holdings. A negative interest rate will have several effects. First, firms will switch from equity finance to loan finance because loan finance is cheaper. They can do this via debt financed share buybacks and special dividends to shareholders, which is exactly what has been happening since the 2008 recession. The result is increased corporate indebtedness and more leveraged balance sheets.

Richard Koo has described Japan, where interest rates has been zero for many years, and where QE has moved long-term interest rates very close to zero as well, as a country where the private sector does not want to have any external debt. Half of the countries corporations featured in the NIKKEI stock market index have no external debt. They used low interest rates to ‘move clear’. I wonder whether negative interest rates will have the same effect. It is a question of expectations. If a fiscal stimulus is expected at some point, then interest rates in the future will go up. This means that debt should be reduced, not expanded, during times of low and negative interest rates.